Affirm: weakness in core revenue

I spent some time on Affirm over the weekend and didn’t come away with the impression it was showing strength.

Quick summary: I believe the high top line growth masks underlying weakness in the core business of facilitating transactions. This weakness is propped up by great performance in the trading side of the business.

Total Network Revenue

Revenue is broken down into 5 segments:

  1. Merchant Network Revenue
  2. Virtual Card Network Revenue
  3. Interest Income Revenue
  4. Gain/Loss on sale of loans
  5. Servicing Income Revenue (negligible)

Affirm calls the sum of the Merchant Network Rev and Virtual Card Network Rev, “Total Network Revenue”. This measures the fees Affirm earns for transactions and GMV that is processed through the Affirm platform. Along with consumer interest payments (to be discussed later), I view this as part of their core revenue.

Here are the numbers for Total Network Revenue ($M)


Year       Q1      Q2      Q3        Q4        
2019      24.7    41.5    38.2      35.9     
2020      40.0    74.9    73.3      87.9     
2021      99.2   110.5    111.8     107.9     

Total Network Revenue Growth YoY


Year       Q1     Q2     Q3      Q4        
2019      
2020      62%    81%    92%     145%    
2021      148%   48%    53%      23%     

Total Network Revenue Growth QoQ


Year       Q1     Q2      Q3      Q4        
2019              68%    - 8%    - 6%
2020      11%     87%    - 2%     20%    
2021      13%     11%      1%    - 3%     

We can see Total Network Revenue growth has been very weak for FY21. Even after considering that it was an unusual year in terms of seasonality, I felt their Q2’21 (Oct-Dec) performance was disappointing at 48% YoY and only 11% QoQ growth.

The interesting thing is that other metrics are not showing such precipitous slowdown in growth. In Q4’21, Active Consumers grew 97% YoY while GMV grew 106%. Yet Total Network Rev only grew 23%!! The only explanation I can think of is that Affirm negotiated high fees with its largest merchants.(Customer concentration: Peloton represented 28% of Affirm’s total rev for FY20 and their top 10 merchants represented 35% of FY20 rev.) Now that the growth of these top merchants are slowing, and as Affirm has to negotiate with smaller merchants, their take rate on each transaction has reduced.

Trading Revenue Saves the Day

Now in Q4’21, the poor growth in Total Network Revenue was made up by strength in other segments: “Interest Income” (grew 111% YoY in Q4 21) and “Gains on sale of loans” (grew 268% YoY in Q4 21)

At first glance, it looks great the interest income is growing well. But during the earnings call, the company said this “Interest income grew 111% to $104 million. However, it is important to note that 40% of the increase of interest income was driven by a 212% year-on-year increase in the amortization of the discount on loans held for investment on the balance sheet rather than from consumer interest payments. The portion of interest income related to consumer interest payments grew 77%”

In Q3’21, Interest Income also had a huge contribution (about one-third) from this item “amortization of the discount on loans held for investment on the balance sheet”

My understanding of “amortization of the discount on loans held for investment on the balance sheet” is that this is more trading in nature: gains (or losses) due to the discount/premium to market when buying loans to be held on Affirm’s balance sheet.

As with most trading gains/losses, my guess is the contribution from this and the revenue segment “Gains on sale of loans” is not ratable and can be volatile.

Overall, these are my conclusions:

  1. Core revenue of Total Network Revenue has not shown strength for the past 3 quarters, partly due to weakness during the holiday season and partly due to seasonality. Consumer interest income payments, also a core revenue, did alright at 77% growth YoY in Q4’21.
  2. The trading side of the business, which I view as secondary revenue, was doing the heavy lifting to give the overall impression that the business was doing well.
  3. The Shopify contributions are unlikely to have contributed to the Network Revenue in a meaningful way so far. When that happens, along with Amazon contribution, (we’ll likely see Network Rev grow strongly) I’d be more interested in taking a stake in the company.

Cedric

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Hi Cedric - very smart post. Thanks for the forensic accounting take on Affirm.

Two more concerns from me on Affirm, (which is at odds vs the Afterpay business model).

  1. Virtual Card
    We just had results from Marqeta which was also touted on this board. Marqeta delivered massive growth in revenues or TPV (+76%) this last quarter as its virtual card issuance ramped - but this came with an equally massive increase in losses (-56% net margin). I haven’t got into the details with Affirm but so far virtual cards haven’t necessarily proved a hugely profitable business. (Marqeta have an agreement with Affirm for something or other).

  2. Longer term interest bearing credit model
    The beauty of Afterpay is that whilst it received its revenues from merchants, (leaving aside negligible late payment fees from consumers), repayments were made within 4 instalments (1 on day of purchase and 3 more over the next 3 weeks). So effectively for a 4% merchant fee it turned over its loan book whilst self cleaning at the same time within 4 weeks. That meant that it earned ~40% annually on capital deployed through the recycling of the lending. Its borrowing facility was at ultra low interest rates and most recently at zero interest convertible loan notes making this an incredibly profitable business and with very low risk.
    Affirm on the other hand have a longer dated interest bearing lending model. Let’s say they take in 12% in interest rates for a 12 month instalment plan. The profitability on this is night and day vs Afterpay’s model with its recycled lending. It is also exposed to more risk.

Ant

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“Amortization of the discount on loans held for investment on the balance sheet” is a standard accounting treatment for investment loans that are acquired below “market rate”.

The “market rate” compares the interest rate that AFRM lends to its customers against the rate of similar loans on the market. The discount means AFRM’s rate is lower than market. The amortization is fixed, so it won’t fluctuate like say unrealized gain/loss on an investment mark to market.

And the amortization is still interest income, but it does mean that the investment loan recorded on AFRM’s books is a bit lower than the actual repayment amount. At the end of the day, I wouldn’t worry too much about it.

Here’s link, scroll down to bonds purchased at a discount, with more details on the general accounting treatment: https://www.principlesofaccounting.com/chapter-9/held-to-mat…

As for revenue from gain/loss on sale of loans, it is expected to be positive (gain) or else AFRM wouldn’t sell/securitize its loans. That said, a loss is possible if the economy is in a free fall, default rates sky rockets, and AFRM is forced to sell to shore up its liquidity.

As for the take rate, you’re right, it is reduced from 5% to 4.3% Q/Q. Page 12 contains a slide on this: https://investors.affirm.com/static-files/80b7c17e-f83f-4bcb…

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